Question

When would the cancellation of debt be included in income?

Answer 1

When a debt owed by the borrower is cancelled, discharged or pardoned fully or partially by the lender, the said amount is treated as income in the hands of the borrower and is reported in the tax-return for that year, in which the cancellation has occurred. The amount is included in his gross income.

The borrower receive a Form 1099-C, informing of "Cancellation of Debt," from the lender who cancelled the debt. Some instances of receiving Form 1099-C include foreclosure of any loan or debt or any major moderation thereof.

Exceptions to the treatment of income in the hands of the borrower :

There are certain exceptions ,where even on receipt of Form 1099-C or extinguishment of debt, the amounts are not treated as income in the hands of the borrower such as the following instances:

1. Loans forgiven as gifts to the borrower or loans cancelled subsequent to the lender's death are not treated as income to the borrower.

2.Debt discharged as a result of the court's bankruptcy formalities , is not an income.

3. Certain student loans ,when forgiven , are not treated as income , when after the cancellation, students serve the government for a certain number of years or agreee to serve in rural areas.

4. In the instance of the borrower being declared insolvent, when the value of his liabilities exceeds that of his assets.

5. When the reduction in debt was solely due to the voluntary reduction in purchase price by the seller of the property, specifically for buying which, the loan/debt was incurred.